Credit experts in Canada warn of creeping negative equity

According to J.D. Power Canada, 53.6 percent of finance agreements industry-wide were 84 months or longer in 2017, that's up from 50.3 percent in 2015.

Dark clouds appear to be gathering over the credit landscape in Canada, and the forecast is beginning to look like pain.

In a March report, credit-rating company Moody’s said the number of auto consumers with negative equity, which occurs when a vehicle buyer owes more on a trade-in vehicle than it is worth, is on the rise in Canada, with the blame, in part, going to longer terms on auto loans.

“Longer consumer auto-loan terms increase ‘negative equity’ ... because vehicle values fall faster than the loan is repaid,” the Moody’s report said. “This shortfall is often rolled into the initial balance of a new car loan, compounding the negative equity and credit risk.”

Spurred by low interest rates, rising vehicle costs and the growing popularity of more expensive light trucks, more Canadian consumers are taking on longer loans. It’s a trend similar to that seen in the United States, where loan terms have been on the rise for years.

“We don’t see that in Canada as much [as in the United States] yet,” said Matt Fabian, director of research and analysis at TransUnion Canada. “But it’s starting because they’re starting to extend the terms a little longer. That’s something that will be coming on the horizon as those [loans] start to expire.”

LONG LOANS GROW

According to J.D. Power Canada, 53.6 per cent of finance agreements industry-wide were 84 months or longer in 2017, that’s up from 50.3 per cent in 2015.

A report released in 2016 by the Financial Consumer Agency of Canada found that extended-term loans, defined by the regulator as terms of six years or more, made up about 60 per cent of the portfolios of the largest Canadian auto-financing companies, and was the fastest-growing category of auto loans in the country.

“While consumers are opting for longer loan terms, they are not necessarily waiting longer to break their current loans,” the report reads. “Most continue to break their auto loans during the fourth year. Because the average term now exceeds 72 months, these consumers are breaking their loans before they have eliminated negative equity and begun accumulating positive equity.”

Fabian said rising negative equity rates could have an impact in other areas. He said insurance companies are beginning to see more customers committing fraud to try getting out of negative-equity situations. He said investigations into reports of stolen or destroyed vehicles are more frequently finding that the vehicle owners were upside-down on their equity.

Rising negative equity will likely keep some buyers out of the market for a new vehicle, instead pushing them into the used market. Fabian also said it could impact which vehicles customers end up purchasing, as an upside-down customer might instead opt for a cheaper vehicle over a more expensive crossover or truck.